Sample Investment Policy Statement
Date: January 2014
The Investment Policy Statement (IPS) is the cornerstone of the investment management process. Investment recommendations will be made in concert with the guidelines that I, ______________ (Client) and Stuart Chaussee (Advisor) agree upon and outline in this document. The IPS opens a channel of communication between us, so that important issues and concerns can be clarified. The IPS was derived from the interview process and your answers to the Risk-Profile Questionnaire. An effectively developed IPS is the foundation upon which our work together will be based:
- It establishes the criteria for matching long-term objectives to an appropriate investment plan.
- It provides a frame of reference that will help us focus on your long-term investment objectives.
- It establishes criteria against which progress can be measured.
Assets and accounts to be covered under this Investment Policy Statement:
All accounts managed in the Client’s name and/or advised by the Advisor at TD Ameritrade or other Custodian. The accounts are listed below:
The accounts will be treated as one aggregate portfolio. This should provide the most efficient method for designing and managing the portfolio. In doing so, each account may have different asset class representation and different performance. This should not detract from the overall investment policy.
Tax-Deferred and Taxable Accounts
Primary Investment Objective
Long-Term Growth & Income
Overall Portfolio Objectives
Consistent with the respective investment styles and philosophies of the Client and Advisor, the Advisor will make every effort to help the Client meet his/her Primary Investment Objective. It is understood that losses may occur in individual securities, and substantial loss is possible (see sample historical data for various allocations in this IPS), but, that risk and losses will be considered at the aggregate portfolio level. The advisor should adhere to the investment management styles for which he was hired and make reasonable efforts to control risks, recognizing that assuming risk is necessary to produce long-term results that are sufficient to meet the investment objectives.
The Advisor and Client have reviewed the Client’s responses to the Risk-Profile Questionnaire. In addition, the Advisor has discussed the various factors that influence your risk tolerance, such as time horizon, investment objectives, volatility of returns, risk of loss on percentage and dollar terms, and has concluded that you are a Long-Term Growth & Income investor. You recognize that there is risk of substantial loss of principal in stocks, bonds and real estate investment trusts.
Also, the stock, bond or real estate investments in the portfolio will not track the performance of major indices and, as a result, the portfolio may underperform those indices. Therefore, the portfolio will be subject to the risks associated with individual stock, bond or real estate investment trust selections. Furthermore, this will be the case for any other individual securities chosen by the Advisor or Client, exchange-traded funds (ETFs) mutual funds or preferred stocks, for example.
The stock market can decline materially as evidenced by two 50% plus declines during this decade and future returns are unpredictable. You recognize the risks associated with stock ownership, as well as the risk of substantial loss (up to 100% for individual positions) in real estate investment trusts, bonds, in addition to stocks, or mutual funds that comprise these securities.
In addition, if cash is raised, in an attempt to reduce risk (see Market Timing section) this may not work to your advantage. Obviously raising cash ahead of a significant market decline could save you money, but if the market moves higher, after raising cash, there will be an opportunity cost (loss of what you could have made while staying in the market).
It is important to point out that I am a one-man firm and do not have the resources of a larger firm. There are times when I may be unavailable (e.g. meetings, vacation, illness) which could have a material impact on the performance of your account. Recognize that you may effect transactions in your account, if need be, by contacting your Custodian directly. The Client has agreed to contact the Custodian directly if he/she wants to effect an order or make a change and cannot reach the Advisor. He/she is aware that there may be a higher cost in effecting transactions directly with the Custodian.
Cash flow considerations
Client has no intention of making any withdrawals for the time being.
Investment time horizon
10 years or longer
Liquidity is necessary to the extent that it meets the Client’s cash-flow needs.
The goal will be to manage the assets in a tax-efficient manner whenever possible.
Academic research suggests that the decision as to how to allocate total assets among various asset classes will have far greater an impact upon performance than security selection and market timing. Increased weighting to higher risk asset classes (e.g. stocks, real estate investment trusts) will increase the risk of loss, often substantial, and volatility too. Increasing an allocation to bonds typically decreases the volatility and risk of a portfolio.
If the target percentage in stocks is exceeded by market appreciation or because of withdrawals, it will typically be brought back in line with the initial target if it exceeds that target by 5% or more (assuming your risk tolerance and financial situation have not changed). This will be reviewed at least on a quarterly basis and any reduction will be done with tax efficiency in mind.
Deciding on your appropriate asset allocation was based on a review of your financial situation during the interview process, preferences and answers to the Risk-Profile Questionnaire.
The initial target allocation will be mostly in dividend-paying stocks (global and domestic---ETFs and/or individual stock holdings). The bond allocation can be in either individual bonds or bond ETFs although they will be limited at the outset (if any). Eventually the portfolio will be a more balanced portfolio with a combination of stocks and bonds. For now, however, with bond yields so low, it is agreed to swap your existing allocations into mainly dividend equity holdings to both reduce costs and provide for better upside and yield---beyond what your bond funds are paying. The allocation may change in favor of one or the other based on prevailing rate or valuations in both asset classes.
Asset Allocation Limits
Every asset class has an associated level of risk and expected return. (See attachment that shows various model portfolio allocations and historical returns.) The amount of assets you invest in each category depends on your investment time horizon, tolerance for risk and acceptable volatility of returns. Given your risk profile and investment objectives, as outlined in this IPS, having a balanced portfolio will typically make the most sense---balanced in dividend stocks and bonds. Having said that and given your “growth-oriented” goals, heavily weighting the allocation to stocks with capital gain potential would be acceptable. See “Monitoring & Reporting” for more on adjusting your target asset allocation. A small amount of cash (money market assets) will be left in all accounts.
The Advisor and Client agree that the Advisor may periodically engage in market timing of equities (or advise the Client to do so) and does not believe in buy-and-hold stock investing. In general, fixed-income/bond positions will be held to maturity, although in certain circumstances bonds may be sold prior to maturity for various reasons (e.g. tender offers, tax-loss selling, before or after downgrade). For stocks or real estate investment trusts, the Advisor may exit positions at any given time and reduce exposure below the initial target allocation as set forth in this IPS, or to zero exposure if deemed appropriate. The Client understands that this may mean loss of opportunity in stocks and may result in underperformance of benchmarks with the stock portion of the portfolio. In addition, if the target percentage in stocks is exceeded by market appreciation or because of withdrawals, it will typically be brought back in line with the initial target if it exceeds that target by 5% or more (assuming your risk tolerance and financial situation have not changed). This will be reviewed at least on a quarterly basis and any reduction will be done with tax efficiency in mind.
Investment Strategy and Constraints
Investment of assets will generally be limited to investments in dividend-paying stocks or individual bonds rated BBB- or better (Investment-Grade) at the time of purchase. In addition, investments may also be made in various exchange-traded funds (ETFs) in either fixed income or stocks. Individual real estate investment trusts or ETFs, mutual funds or preferred stocks may also be purchased if deemed appropriate given the Client’s investment objectives and risk profile. At all times the Advisor will do his best to maintain diversification of assets, whether diversified within an asset class or among various asset classes. If an ETF is purchased, and it holds many individual securities (i.e. Dow Jones Industrials, which is comprised of 30 stocks), that would be consistent with the term “diversification.”
Note, the Client may decide to hold or buy stocks or mutual funds that do not pay dividends, and may choose to do so despite the Advisor’s advice. The Client obviously assumes all risks associated with ownership of these positions.
The Custodian (TD Ameritrade) will provide custodial services for the Client. The allocation may be balanced, depending on prevailing dividend rates and valuation and bond yields. The Client acknowledges the risks of having a concentrated portfolio of stock and the risks associated with stock ownership and/or fixed income ownership. The investments at the outset will be in dividend-paying exchange-traded funds and/or dividend-paying stocks. The Client acknowledges that implementing changes may incur fees and or taxes capital gains taxes. This has been reviewed by the Client and Advisor before implementation.
Monitoring & Reporting
Each asset class in which the portfolio (viewed in the aggregate) is invested shall be reviewed on a quarterly basis, or more often, by the advisor and may be rebalanced back to the recommended weighting when appropriate. If the target percentage in stocks is exceeded by market appreciation or because of withdrawals or other reasons, it will typically be brought back in line with the initial target if it exceeds that target by 5% or more (assuming your risk tolerance and financial situation have not changed). In addition, for stocks or real estate investment trusts, the Advisor may exit positions at any given time and reduce exposure below the initial target allocation as set in this IPS, or to zero exposure, if deemed appropriate. When necessary and/or available, cash flows will be deployed or withdrawals will be made in a manner consistent with rebalancing the asset allocation.
The Client will receive monthly statements from the custodian and will receive notification either by e-mail or standard mail, of all transactions that occur. In addition, the Custodian will provide 1099s to the client each year. The Advisor will send quarterly reports to the Client, at the end of each quarter, which will include all security positions. Invoices will also be sent at the end of each quarter although advisory fees will typically be automatically deducted from accounts at the end of each quarter, as specified in the Investment Advisory Agreement. The Advisor will also provide a realized gains and losses report to the Client at the end of each tax year.
Duties & Responsibilities
The Client should always be cognizant that he or she has the ultimate responsibility for the investment of the assets. The Advisor shall assist the Client to discharge this responsibility with the care, skill, prudence and diligence under the circumstances then prevailing, that a prudent person, acting in a like capacity and familiar with such matters, would use in such conduct with like aims.
The Advisor is responsible for assisting the Client in making an appropriate asset allocation decision based on the financial needs, objectives, and risk profile of the Client and implementing such decisions. The Advisor will also monitor the portfolio no less often than quarterly.
The Advisor is a Registered Investment Advisor and shall act as the investment advisor to the Client, pursuant to the Investment Advisory Agreement between the Client and the Advisor.
The Client should provide the Advisor with all relevant information on financial condition, net worth, and risk tolerances and shall notify the Advisor promptly of any changes to this information. Failure to disclose all relevant information will limit the Advisor’s ability to provide appropriate investment advice.
Investment Policy Review
To assure continued relevance of the guidelines and objectives established in this IPS, the Client plans to review the investment policy at least annually and will notify the Advisor if anything has changed in his/her investment objectives or financial situation, or if there should be any restrictions placed on the portfolio.
By committing our agreed upon thoughts to a written document, we minimize the potential for conflict and general misunderstandings. For this reason I ask you to please sign this IPS to confirm that you concur with its contents. In signing this agreement you acknowledge that you are comfortable with the risk-profile indicated and the suggested allocations to stocks, bonds, real estate investment trusts and cash equivalents, and that you understand the risks associated with each asset class.
I/we have reviewed and agree with the Investment Policy Statement as outlined in this document. I/we agree that this document shall provide guidelines under which my/our investment portfolio will be managed.
Client Signature Date
Client Signature Date
Stuart Chaussee/Advisor Date
Risk Profiles: (Your Risk Profile is indicated in bold)
Moderate Income: Moderate Income investors seek income consistent with a modest degree of risk. They are willing to accept a moderate level of income (typically higher than CDs or money market rates) in exchange for moderate risk. Equities will typically be a small percentage of the portfolio (dividend-paying stocks). Bonds purchased will not be rated below BBB- at the time of purchase, and, will generally be shorter in maturity (1 to 5 years) although intermediate and long-term maturities may be purchased. Moderate Income investors generally are not concerned with keeping pace with inflation. Note, there is risk of loss of principal, perhaps substantial loss, in stocks, bonds and in real estate investment trusts.
Moderate Growth & Income: Moderate Growth & Income investors seek to balance potential risks with the goal of moderate growth and income. Equities may represent up to 65% of the portfolio, assuming the stock dividends are sufficient to help meet the Client’s income needs. Bonds purchased will not be rated below BBB- at the time of purchase. Also, bonds purchased may be invested in intermediate on longer maturities to create higher income. Note, there is risk of loss of principal, perhaps substantial loss, in stocks, bonds and in real estate investment trusts.
Long-Term Growth & Income: Long-Term Growth & Income investors seek a significant level of growth and income, and their risk tolerance allows them to employ higher risk and more aggressive strategies that may offer higher potential returns (with the risk of substantial loss). Equities are typically the primary asset in the account and will generally pay dividends. If bonds are purchased they will not be rated below BBB- at the time of purchase. Note, there is risk of loss of principal, perhaps substantial loss, in stocks, bonds and in real estate investment trusts.
Model Portfolio Allocations and Historical Risk (1926-2008):
Worst year (1969) -8.1%
Years with loss 13
80% bonds / 20% stocks:
Worst year (1974) -10.3%
Years with loss 12
70% bonds / 30% stocks:
Worst year (1931) -14.2%
Years with loss 14
60% bonds / 40% stocks:
Worst year (1931) -18.4%
Years with loss 16
50% bonds / 50% stocks:
Worst year (1931) -22.5%
Years with loss 17
40% bonds / 60% stocks:
Worst year (1931) -26.6%
Years with loss 21
30% bonds / 70% stocks:
Worst year (1931) -30.7%
Years with loss 22
20% bonds / 80% stocks:
Worst year (1931) -34.9%
Years with loss 13
Worst year (1931) -43.1%
Years with loss 25
Note: Source is the Vanguard Group. These historical returns may not be indicative whatsoever of future returns. Past performance is no guarantee of future returns.
Stocks/Equities: Stocks/equities represent a share of ownership in a corporation. Stock returns are based on company’s dividends and profits and how investors assess its potential for future profits. Historically, stocks have provided the highest returns over time, but stock prices fluctuate, sometimes dramatically, and investors can sustain substantial losses. There is no protection of principal and dividends can be reduced or eliminated also. Investors typically choose stocks for growth of capital, which can hopefully keep them ahead of inflation over the long term. There is risk of substantial loss of principal in stocks.
Bonds: Bonds are IOUs issued by governments, agencies and corporations. Interest-rate changes directly affect prices and returns of bonds, but in general, bond prices fluctuate less than stocks. Investors typically choose bonds to receive income and to also diversify stock portfolios. There is risk of substantial loss of principal in bonds.
Credit Quality of Bonds
High Quality: Bonds that have a credit rating of AAA and AA are categorized as high quality.
Medium Quality: Bonds that have a credit rating of less than AA but greater than or equal to BBB- are considered medium quality.
Low Quality: Bonds that have a credit rating of less than BBB- are considered low quality.
Short-term: 5 years or less
Intermediate-term: 5 to 10 years
Long-term: 10 years or longer.
Real Estate Investment Trusts
A real estate investment trust is a tax designation for a corporation investing in real estate that reduces or eliminates corporate income taxes. In return, REITs are required to distribute 90% of their income, which may be taxable, into the hands of the investors. There is risk of substantial loss of principal in real estate investment trusts.
Cash-equivalent investments: A cash investment is a very short-term IOU issued by a government, corporation, bank, or other financial institution. Using the interest payments from such IOUs, money market mutual funds provide income---most often, less than provided by bonds, while maintaining a stable price of $1 a share. Investors typically rely on these types of investments to meet liquidity needs (withdrawal needs) and short-term goals. There is risk of loss due to inflation when investing in low-yielding cash-equivalent investments.
Copyright 2014 Stuart Chaussee & Associates, Inc.